Busch: Fed's Reach Into Private Sector Has Limits

In a letter to Senate Banking chairman Christopher Dodd, US Federal Reserve Chairman Ben Bernanke rejected the idea that the central bank should provide assistance to automakers, saying that such aid would involve the Fed in “industrial policy,” an area best left to Congress according to Bloomberg.

"Today, GMAC LLC, the auto and consumer lender, said it hasn’t met the conditions needed to become a bank. U.S. regulators won’t approve the lender’s application to convert to a bank holding company unless all the requirements are fulfilled," the company said today in a release on PR Newswire.

The message is clear: the Fed wants to pull back from the overly aggressive policy it has been pursuing with its reach into the private sector. To me, this is great news as someone has to think about an endgame or exit strategy from this financial socialism. There is hidden danger to the government's actions in providing backstops to re-start certain aspects of the credit markets. A fine example is what happened with the commercial paper program that was set up to provide comfort to investors. CP issuance was declining prior to the announcement, but afterwards it collapsed until the program started at the end of October.

Why? Think about it from an investor standpoint. Why would you risk investing in CP that wasn't backstopped by the US government when you could wait 3 weeks and get it? This is the major problem going forward for the markets. Unless paper is guaranteed by the US government, investors will ask for a significant risk premium on the instrument. This translates into higher interest rate costs for companies and a stratified economic playing field favoring only the highest rating.

If Illinois teaches us anything, it's that unscrupulous and unrestrained politicians will attempt to extract either monetary gain or social gain from their ability to make important economic decisions. This is not just the province of a wayward state, but can occur at all levels of government especially when they have the direct authority over how projects are managed. How TARP funds will be managed in the future, who is the Car Czar, what instruments are purchased by the Federal Reserve to expand their balance sheet, and what companies get money from the "Shovel Ready" projects that will be funded via the upcoming massive Obama stimulus program are all going to have to face this issue.

At the minimum, government is inefficient in allocating resources. At the worst, they allocate resources based on political favors and based on enacting social policy. This is why the letter by Fed Chairman Ben Bernanke is a step in the right direction. We need to hear more of this from the incoming US Treasury Secretary Geithner to make it clear to Congress that the reach into the private sector has a limit.